Investors have had a lot to digest over the last four to six weeks and certainly the pace of change, the pace of the news flow, has been unprecedented. Whether I apply that to the pace of the transmission of the virus and the adjustments we need to make need to make our daily lives, whether it be to the extent to which markets have repriced across the board, and I’d also apply that to the extent to which policymakers have stepped up to the plate in terms of both monetary and fiscal policy, but also in terms of social policy to manage the virus as well.
The good news is I think that a lot of the bad news has already been priced. The bad news, though, I think is that we now need to deal with the reality and as that sort of reality rolls through I think we will be in for a period of continued volatility in markets. So whereas we are seeing much lower levels of equity markets, we are seeing higher credit spreads, I think it’s a little bit too early to declare the worst is behind us. Certainly better levels, certainly, I think an interesting time to be thinking about our investment options, but not a time to be rushing head long into markets simply because we've seen prices adjust.
What key indicators are important?
There are four things we're considering carefully at the moment:
Economic news flow. Markets have moved ahead of that and as the data starts to flow through we will get much greater clarity as to the impact of the virus and the associated shutdowns on the key parts of the global economy.
- Clarity about the shape of the recovery. What we'd certainly all like to see is a V shape, and I think policymakers would like to see a V shape, hence the extent to which they've really stepped up with quite aggressive monetary and fiscal stimulus. In Australia we are seeing fiscal stimulus in the order of 11% of GDP. Due to the damage done to key parts of the global economy, a V shape is an optimistic scenario. My expectation is more of a U shape and an extended bottom. Hopefully we start to see recovery coming through towards the end of the year.
Corporate profits. Our modelling suggests that we could see profits globally fall in the order of 30-40%, potentially more. As we start to see the impact of the shutdown flowing through in the data we'll have greater clarity on the impact on the corporate sector. We entered this crisis with a relatively highly levered corporate sector, which will make key parts of the corporate sector quite vulnerable. We'll be looking at defaults and generalised signs of distress in the corporate sector.
- Stabilisation of the virus. We are all experts now in watching the COVID curves, but we would like to see evidence of that peaking and starting to moderate before we get too confident about risk taking.
How we are positioning our portfolios?
We started or went into this crisis from a relatively defensive position on the basis that we thought markets were pricing perfection, we thought that was pretty unlikely. We’re looking at markets from a relatively positive perspective.
We are seeing a lot of volatility, I think big falls followed by a big bounce is actually relatively normal market behaviour. More often than not markets will move back to retest those lows and we think that's quite likely, given the nature of this shock.
We do broadly see this as a good window to be looking at reconstructing our portfolios, there are some good opportunities flowing through in credit, and in the equity space as well. We've started to step into the market cautiously, we have added about 5% to our equity positioning, we've stood in the market and taken advantage of some of the dislocation buying some of the domestic bank tier one paper, but subject to the availability of supply in that segment of the market.
We've taken some profits on our long US dollar position. We've also shifted some of that duration positioning out the curve as well as central banks have targeted the front end of curves. And we've also taken advantage of the volatility and started to sell some equity put options.
A cautious step back into the market, but as we work through a number of those issues and we get more clarity, we do expect to be using this repricing in markets to rebuild our risk positioning in the portfolio.
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The hospital pass to the bag holders hasn't even been disguised this time around. The smart money said "Right! I'm off" and out the door they went. Don't expect them back anytime soon.